The Big Picture for the Week of August 8, 2010

Special nerd fight on the Clackamas River edition.

The nerd fight in question (just teasing a little) is the apparent different conclusions that have been drawn about the proposed First Trust Smart Phone ETF (proposed ticker FONE I believe) by Index Universe and ETF Database.

Obviously this will be a very narrow fund if it lists. Most shocking to me however is that it will have 84 holdings, at least that is the number being reported as being in the underlying index. Keep in mind the GlobalX Lithium ETF (LIT) only has 20 holdings so 84 is a lot.

I would sum up IndexUniverse's take as this being unnecessary because anyone interested in this space would be better off just buying a stock or even a couple of stocks for the exposure. This is a valid point. The idea of a niche not being captured in an index fund has come up before. A point I've made in the past about biotech or the Healthshares is that sometimes one large holding in an index might win at the expense of another large holding thus canceling each other out.

FONE will surely be heavy in Research In Motion (RIMM), Google (GOOG) and Apple (AAPL). If you look at a chart of the three you'll see that they have taken different paths to different results which could be a drag on the fund should they continue this pattern in the future. The way to avoid this would be picking of stock but of course the risk is picking the wrong one.

ETF Database thinks this will be quite popular as a trading vehicle and this too is a valid point. RIMM, GOOG and AAPL are of course all very popular for several reasons including trading and an ETF that takes in all three with prominent weightings would seem to have the potential to be very popular. I would also add that if there are 84 names in the index then those three stocks do not have to each be weighted at 20%. Were they to be weighted at 5% each (have not read the prospectus as I am on vacation) then the canceling each other out idea would be off the table in terms of being a drag on the fund.

Another point not brought up in either post is the utility for investors (probably mostly professionals) for paired trading like going long a stock or two and short the ETF or other forms of hedging with with the ETF or options that might come on the ETF. If AAPL ends up having a 90% correlation and FONE options end up being much cheaper for some reason then maybe FONE puts become a better hedge than AAPL puts? That sort of thing.

Generally I am all for anything listing but am not a believer that all ETFs, or even most ETFs, are right for most people. I think the Chinese sector funds are a fantastic idea but going that specialized is not right for some folks and for some others (like smaller RIA located in Northern Arizona) the volume isn't quite there yet.

A couple of clients own AAPL at their request.

Both pictures are from the Clackamas River.